Economist surprised at Fed's economic rescue plan

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September 13, 2012 at 2:15 PM

In an action to potentially foster job growth and reduce unemployment, the Federal Reserve today announced a third round of mortgage-backed asset purchases at the unprecedented pace of $40 billion of mortgage debt a month.

"I'm surprised the Fed did something as bold as this. It seems as if the Fed is seeing something in the economy that must be more dire than what most of us who have been conservative in our forecasts having been seeing," said Patrick J. O'Keefe, director of economic research at the Roseland office of J.H. Cohn.

In a statement released at the end of its two-day meeting, the Federal Open Market Committee said its actions — which include holding the federal funds rate near zero through at least mid-2015 — will "increase (its) holdings of longer-term securities by about $85 billion each month through the end of the year," which it hopes will "put downward pressure on longer-term interest rates, support mortgage markets and help to make broader financial conditions more accommodative."

As massive job growth is the ultimate goal of the Fed’s plan, the committee said if the labor market outlook does not show any signs of substantial improvement in the coming months, it plans to “continue its purchases of agency mortgage-backed securities, undertake additional asset purchases and employ its other policy tools as appropriate until such improvement is achieved.”

While O’Keefe said the Fed’s so-called “QE3” plan is relatively cost free, with no short-term threat of inflation, “there’s no clear path by which increased liquidity is expected to find its way into job market.”

“The unemployment rate has gone down substantially since around the time QE2 came into effect (in November 2010), except the progress has come largely from a reduction in the labor force participation rate,” O’Keefe said. “There’s been no explanation or proof to show how increasing liquidity under current conditions is going to contribute to faster job growth.”

While O’Keefe said the Fed’s efforts will allow commercial banks to “continue their recapitalization out of the financial crisis, because they’ll earn interest on their excess reserves and lend in a cost-free way,” he noted stricter lending standards from the federal government and a lack of consumer demand means the Fed’s efforts will have “no impact whatsoever on banks’ lending.”

“As banks face the implementation of Dodd-Frank, they’re more responsible for assessing the capacity of a prospective borrower to finance and afford loans,” he said. “When you’re being told you can only lend to those most credit worthy — who already have plenty of money — no injection from the Fed is going to produce a flow of lending.”

Kevin Cummings, president and CEO of Investors Bank, said the Fed’s decision to “keep interest rates low for 11 straight quarters is not going to help first-time home buying, because it doesn’t create a sense of urgency.”

“Twenty years ago, people were buying homes because they knew the interest rates were only going to get higher. Now those rates will be staying close to zero until 2015, so people are thinking there’s no rush,” Cummings said. “We look at housing stocks and sales and say they’re up from last year, but we have to remember last year was terrible. I think the banks want to lend — and they’ll be even more flush with liquidity now — but there’s just not a lot of people buying homes anymore to get that lending going.”